From buildings to machines, equipment and tools, every business will have one or more fixed assets likely susceptible to depreciate or wear out gradually over time. For example, with constant use, a piece of company machinery bought in 2015 would have depreciated by 2019. The concept of depreciation is that simple.
When calculating a business's contra account, bad debts, depletion and depreciation of the company's assets are all crucial deductions to make. In order to write off the cost of expensive purchases and calculate your taxes accurately, knowing how to determine the depreciation of your company's fixed asset is critical.
There are three popular methods for calculating depreciation. Still, the straight-line depreciation method is widely employed for its simplicity and functionality to determine the depreciation of assets being used over time without a particular pattern.
Using the straight line depreciation method in calculating a company's depreciation of assets is highly recommended because it is the easiest method and results in the fewest calculation errors.
What is Straight Line Depreciation?
With straight line depreciation, the value of an asset is reduced consistently over each period until the salvage value is reached. With this method, the depreciation value is always constant over the asset's useful life because it is believed that the assets are functional and provide the same amount of benefit to the company over its useful life.
A company building, for example, is being used equally and consistently every day, month and throughout the year. Therefore, the depreciation value recorded on the company's income statement will be the same every year of the building's useful life.
What are Other Types of Depreciation Methods?
Small and large businesses widely use straight line depreciation for its simplicity, accuracy, and functionality, but other methods of calculating an asset's depreciation value exist.
Depending on how often they are used, different assets can wear out at different rates, and any method of calculating depreciation value may come in handy.
The other popular methods used in calculating depreciation value are; Sum of years method or unit of production method and double declining balance method.
How to Calculate Straight Line Depreciation?
Calculating the depreciation of a company asset using the straight line depreciation method can be done by following the following steps:
- Find out the cost or price of acquisition of the fixed asset
- Determine the expected or estimated useful life of the asset
- Subtract the estimated salvage value of the asset from its initial cost of purchase. This will give the depreciable asset cost
- Divide the depreciable asset cost by the number of years the asset is estimated to be in use. This will give the amount of annual depreciation.
What is the Formula for Calculating Straight Line Depreciation?
The formula for calculating straight line depreciation is:
Straight line depreciation = (cost of the asset – estimated salvage value) ÷ estimated useful life of an asset.
Where:
Cost of Asset is the initial purchase or construction cost of the asset as well as any related capital expenditure.
Estimated Salvage Value is the scrap or residual proceeds expected from a company asset's disposal after the end of the asset's useful life.
Estimated Useful Life of Asset is the estimated time or period that an asset is perceived to be useful and functional from the date of first use up to the day of termination of use or disposal. Useful life is often expressed in months or years.
What Are Some Examples of Using Straight Line Depreciation Method?
Example1
A business purchased some essential operational machinery for $7,000. The machine is estimated to have a useful life of 10 years and an estimated salvage value of $2,000.
To calculate the straight line depreciation value of this machinery we have to calculate the following;
Annul depreciation of the machinery = cost of the machinery – estimated salvage value ÷ estimated useful life
Annual depreciation = $7,000 - $2,000 ÷ 10
= $5,000 ÷ 10 = $500
According to straight line depreciation, the company machinery will depreciate $500 every year.
i.e. For year 1, the machinery will have a depreciation value of $500
Year 2 = depreciation value of $500
Through year 3, 4, 5, 6, 7, 8, 9, 10, the depreciation value remains $500.
Example 2
A company just purchased a delivery truck that costs $50,000. The vehicle is estimated to have a useful life of 5 years and an estimated salvage of $15,000.
What will the depreciation value of the truck be if we use the straight line depreciation method?
Annual depreciation value of the truck = cost of the machinery – estimated salvage value ÷ estimated useful life.
Therefore, annual depreciation = $50,000 - $15,000 ÷ 5
= $45,000 ÷ 5
=$9,000
This means that from the year of purchase, the truck will depreciate at $9,000 up to the 5th year.
When keeping your company accounting records, straight line depreciation can be recorded on the depreciation expense account as debit and credit on the accumulated depreciation account.
A fixed asset account is reduced when paired with accumulated depreciation as it is a contra asset account.
The estimated useful life value used in our calculations are for illustration purposes. If you are calculating depreciation value for tax purposes, you should get the accurate, useful life figure from the Internal Revenue Agency (IRS).
The IRS has categorized depreciable assets into several property classes. These classes include properties that depreciate over three, five, ten, fifteen, twenty, and twenty-five years.
Conclusion
As a business owner, knowing how to calculate straight line depreciation of your company's fixed assets is crucial to your business's success.
But, you don't have to do it yourself, especially if you run a large company with many assets that are liable to depreciation. You can always hire a professional accountant solution to handle this part of your business.
